My opinions on value investing. The idea is to create a value discussion on stocks and concepts. You might find this blog leaning a bit towards Dalal Street but the concepts should travel well across global markets.
Please note that I may or may not have a position in these stocks. Please use these opinions after through independent research and at your own risk.

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Wednesday, April 1, 2015

Common anchors and how to get rid of them

Anchoring is defined as the common human
tendency to rely too heavily on the first piece of information provided to make
subsequent decisions. Dangerous market anchors in the world of portfolio management are (but not limited to):

Index P/E – relatively valuing
companies to the index P/E is very dangerous

Price relative to the all time
high – if a stock was trading at 50% over its fair valuation and is now trading
at 25% over its fair valuation, it does not imply that one should buy it just
because it’s down by 15%

Trading close to the all time
or 5 year or one year low – Just because something is at an all time low or
close to it does not mean it’s cheap. There could be something really bad going
on with the company

Buying on days when the stock
is down and selling when it’s up – again these are path dependent results and
do not add to your returns. If it did many people would chase this arbitrage,
some might even write computer programs to do this, and it would no longer be
true. If you don’t believe me you can back test this to realize that the return
generated from doing this is pretty much the cost of trading.

The way I have found to get rid of my
biases is to have a simple list of companies with growth, expected return on
capital, fair value and current value. This removes my relative bias and lets
me look at the totality of the trade.

Some portfolio manager might ask that this is contrary to
what I have been preaching about macro factors. Macro factors are just a
general direction in which you can look to understand whether a gross mistake
is being made, but as stated earlier they can form a very small part of the
decision making. Typically their only use is to instil the right amount of fear
in you before trading.

How does the intelligent investor know it’s an anchor? Sit back,
relax, and think through it with the assumption that markets are NOT efficient.
If it makes rational sense to you then it’s not an anchor else it is.